Doubting the wisdom of global diversification?

This has been a very tough period for the Word Allocation category. But I do think it would be a mistake to capitulate at this point. There are couple of things to think about. First of all, people have done very well over the last five years simply by buying into the U.S. equity market and going to sleep. Well, that has been a winning strategy, the end result of that is right now U.S. stocks are very expensive relative to history.

There are several other headwinds as well. The dollar has been stronger over the past couple of years, earnings growth has been slowing and the buyback trend is fading. The upshot of which – it’s not clear if you are going to get the same level of returns simply from owning the U.S. equities over the next five or ten years, which you have over the previous five or ten. So thinking about more diversification is important.

Now, I know for lot of people that does not sound like a winning proposition right now. They have done well with a narrow approach. They say “Why be diversified?” I think it’s worth reminding everyone – we have been here before. There have been other periods in the market, think about the late ‘90s, when simply buying tech stocks and going to sleep was a good idea. But over the long term, history suggests that having a diversified portfolio – both in terms of different asset classes, but also in terms of different geographies – has helped lead to better risk-adjusted returns.

The argument for paying a fee for active right now and for the fund is that there are parts of the market that are difficult-to-access by yourself that the fund can take advantage of. So think about categories like convertible bonds, preferred stock and bank loans. All of which are little bit difficult to get through other instruments, but offer some interesting prospects in this market. Now, the last five years you did not really need to avail yourself of many of these categories. Simply buying U.S. stocks, buying U.S. bonds and stopping, was a winning strategy.

That’s probably not going to work as effectively over the next five years, partly because valuations are stretched and instead, people also think “What are some of the niche categories that I can look towards?” The second thing to consider is we are in a volatile market. Since last August volatility is generally rising. We had several spikes during which we have seen stocks really get hit. Something that has not happened in many years. Having the flexibility to rebalance, to change the portfolio on a daily basis when needed is a very important characteristic in this type of market. And having that flexibility is one of the factors that suggest that you can better manage risk, better deal with risks.

This has been a difficult period for the fund. We have seen several unusual aspects in the market. We have seen interest rates go practically to zero, we have seen markets in the U.S. continue to advance relative to the rest of the world, despite the fact that earnings have basically grounded to a halt and valuations are very expensive. So it’s natural to think that it is simply time to give up to look for somewhere else to invest. I think that’s a mistake.

If you go back in the last 25 years, the fund has a proven track record of adding value over the long term. Not just in producing equity like returns, but also doing so with less risk¹. And that’s important. Because as you talk to your clients, as you try to navigate your clients in the very difficult markets, one of the most important things you can do as an advisor is to keep them invested, keep them invested during these periods of turbulence. That should be easier with a fund with a proven track record of managing volatility through similar periods.

I don’t think this is the right time to redeem. I think, this is the time to think about the long term. One of the defining characteristic of the fund is - it has a value orientation. And the thing about value is that it does not always work. There are periods, often long periods, when value is ineffective. Think back to late 90s, when everyone was paying incredibly high multiples for companies without proven track records. For a while that seemed like a good idea, it didn’t end well.

The reason you hold the fund over the long term is that the value generally works over longer periods. And it’s often at the bottom when it seems the most difficult. So if I have got a client with 5-, 10-, or 20- year horizon some with many years to retirement, this is the time to think about should I even be adding to my allocation. Truly take advantage of the fact that right now, there are segments of the market that are cheap and we think they offer prospects for long term returns.